The Week Ahead: Year of the Rat

Foreign Exchange: The Week Ahead
Year of the Rat
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Last week, the US and China officially signed their Phase 1 deal. Despite having a signed deal, the US will maintain its tariffs on Chinese imports that are roughly 14.5% higher than before the trade war started. With January 25 marking the Lunar New Year, a key question for the upcoming year will be the ability of China's economy to withstand the impact of US tariffs. Here are some reasons to be constructive on China's economy as well as the global economy as a whole.

According to recent trade data, US tariff actions have caused Chinese exports to the US to drop 12.5% and reduce China's surplus with the US by 8.5%. However, China's overall exports have risen by 0.5% and its total trade surplus has risen by ~20%. The US-China conflict clearly represents an economic headwind, but diversification has buffered some of this impact.

Beyond trade, the Chinese government has also taken monetary and fiscal steps to support the economy. On the monetary front, the government increased market liquidity by cutting its reserve rate ratio at the beginning of January. Fiscally, local government special purpose bond issuances have been frontloaded to Q1 and December 2019 brought a noticeable uptick in the number and value of infrastructure projects that have been approved.

However, while the steps above will help short term economic performance, the key to maintaining growth in China revolves around its ability to maintain a relatively high level of potential growth. This is where China's structural reforms, service deregulation and investment in technology could become vital. Chinese state-owned enterprises have a much lower level of efficiency than the private sector and many service sectors remain heavily regulated. By removing these constraints to productivity, the hope is that China will be able to prove that the current economic slowdown is cyclical in nature rather than due to a deceleration in long term growth potential.

FORECASTS

EUR

At the end of last week, EURUSD dipped on strong US economic data that shows the US economy continuing to perform. This week, market focus will be on the ECB meeting that will likely be a non-event, but there are risks for a slightly hawkish surprise given recent data flow and Governing Council member comments. Market focus should be on Lagarde's comments around the balance of risks, timeline and aim of the strategy review. Bias remains for EURUSD to move higher.

GBP

The GBP moved lower this past week as poor economic data and dovish BoE comments have pushed up market expectations for a rate cut later this month. Specifically, BoE officials indicated that they would support a cut if data didn't improve. Data not only didn't improve, it actually deteriorated over the last week. Expect the GBP to remain pressured as poor data and cautious policy makers support the view for a cut. However, with fiscal stimulus in the pipeline, it is possible the BoE elects keep its powder dry and monitor fiscal policy's impact.

JPY

The BoJ meeting this week is also expected to be a non-event as the BoJ should keep all its policy targets and forward guidance unchanged. Pressure for BoJ action has eased with a pullback in global tensions, improving Chinese data and recently announced fiscal stimulus package. Near term, expect persistent and large Japanese outflows to keep the JPY weak.

CAD

Market hopes that a run of poor CAD data could lead to a dovish BoC pivot looks to have been a bit premature. Recent BoC comments indicated a comfort with the current policy stance given that inflation is on target, global risks have declined and the labor markets remain resilient. Additionally, the bank has downplayed the recent run of mixed data, citing one off factors. Expect the BoC to remain data dependent but given the positive factors above, the bar for a cut has been raised. This means that it would likely take a sustained run of poor data to warrant further easing. As such, expect the CAD to remain supported.

CNY

The Phase 1 deal between the US and China was signed last Wednesday but the yuan barely noticed. This muted reaction illustrated how well priced in the trade deal was. As such, it is unlikely the CNY will benefit further from the Phase 1 deal, but expect Chinese authorities to strive for currency stability to avoid jeopardizing further trade negotiations and Phase 1 enforcement. For next week, also be aware of the seasonal selling of USD ahead of the Lunar New Year.

AUD

The Phase 1 deal represents a double edged sword for the AUD. The reduction in trade tensions is positive for global sentiment but China's increased purchases from the US likely will come at Australia's detriment. The RBA is scheduled to review the economy when it reconvenes in February, making upcoming data releases more important than usual. With work left to do on the bank's employment target, keep an eye on this week's jobs report. The bushfire crisis adds another headwind to an already soft economy. The bias remains for AUD lower.

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

1/17 Japan Expectations for rates to be unchanged at -0.1%
1/22 Canada Expectations for rates to be unchanged at 1.75%
1/23 ECB Expectations for rates to be unchanged at -0.5%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

1/22 US Existing Home Sales MoM Expectations for a 1.5% increase
1/24 US Services and Manufacturing PMI Expectations for a both to print 52.5
1/22 CA CPI YoY Expectations for a 2.3% increase
1/24 CA Retail Sales MoM Expectations for a 0.9% increase

Europe/Eurozone 

1/24 EZ Services, Manufacturing and Composite PMI Expectations for a 52.8, 46.8 and 51.2 print, respectively
1/21 German ZEW Current Condition and Expectations Survey Expectations for a -13.5 and 15.0 print, respectively
1/24 German Services, Manufacturing and Composite PMI Expectations for a 53.0, 44.5 and 50.5 print, respectively
1/21 UK Unemployment Rate Expectations for a 3.8% print
1/24 UK Services, Manufacturing and Composite PMI Expectations for a 51.0, 48.7 and 50.7 print, respectively

Asia/Japan, and New Zealand 

1/22 Japan Trade Balance Expectations for -170.0 billion yen print
1/21 AU Jobs Report Expectations for a 11.0k print


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